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The Mythology of Capital - Mises Institute

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The Mythology of Capital

By F.A. Hayek

Posted on 3/23/2007

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I. Professor Knight's argument

II. On some current misconceptions:

The investment periods and technological progress

They refer to factors, not products

The aggregate of such periods cannot be reduced to an

average, nor is measurability essential

The periods refer always to the future, never to the past

The concept does not depend on a distinction between

original and produced means of production

Nor is it only the original means of production whose

investment periods can be changed

III. Professor Knight's criticism based on a misunderstanding

IV. His own position prevents him from giving any explanation

of how the limitation of capital restricts the increase of output

V. An erroneous assertion following from his fundamental

position: the value of capital goods when interest disappears

VI. Problems of capital and "perfect foresight"

Notes

[This article was originally published in The Quarterly Journal of

Economics, Vol. 50, No. 2. (Feb., 1936), pp. 199-228.]

With every respect for the

intellectual qualities of my

opponent, I must oppose his

doctrine with all possible

emphasis, in order to defend a

solid and natural theory of

capital against a mythology of

capital. ÏE. v. Bhm-Bawerk,

Quarterly Journal of

Economics, vol. xxi/2, February

1907, p. 282.

I. Professor Knight's argument

Professor Knight's crusade against the concept of the period of

investment [1] revives a controversy which attracted much attention thirty

and forty years ago but was not satisfactorily settled at that time. In his

attack he uses very similar arguments to those which Professor J.B. Clark

employed then against Bhm-Bawerk. However, I am not concerned here

with a defense of the details of the views of the latter. In my opinion the

oversimplified form in which he (and Jevons before him) tried to incorporate

the time element into the theory of capital prevented him from cutting

himself finally loose from the misleading concept of capital as a definite

"fund," and is largely responsible for much of the confusion which exists on

the subject; and I have full sympathy with those who see in the concept of a

single or average period of production a meaningless abstraction which has

little if any relationship to anything in the real world. But Professor Knight,

instead of directing his attack against what is undoubtedly wrong or

misleading in the traditional statement of this theory, and trying to put a

more appropriate treatment of the time element in its place, seems to me to

fall back on the much more serious and dangerous error of its opponents of

forty years ago. In the place of at least an attempt of analysis of the real

phenomena, he evades the problems by the introduction of a pseudo-concept

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devoid of content and meaning, which threatens to shroud the whole problem

in a mist of words.

It is with profound regret that I feel myself compelled to dissent from

Professor Knight on this point, and to return his criticism. Quite apart from

the great indebtedness which all economists must feel towards Professor

Knight for his contributions to economic theory in general, there is no other

author with whom I feel myself so much in agreement, even on some of the

central questions of the theory of interest, as with Professor Knight. His

masterly expositions of the relationship between the productivity and the

"time-preference" element in the determination of the rate of interest [2]

should have removed, for all time I hope, one of the worst

misunderstandings which in the past have divided the different camps of

theorists. Under these conditions anything which comes from him carries

great weight, particularly when he attaches such importance to it that he

tries "to force his views on reluctant minds by varied iteration." It is not

surprising that he has already gained some adherents to his views. [3] But

this only makes it doubly necessary to refute what seems to me to be a

series of erroneous conclusions, founded on one basic mistake, which already

in the past has constituted a serious bar to theoretical progress, and which

would threaten to balk every further advance in this field, if its

pronouncement by an authority like Professor Knight were left

uncontradicted.

This basic mistakeÏif the substitution of a

meaningless statement for the solution of a problem

can be called a mistakeÏis the idea of capital as a

fund which maintains itself automatically, and that,

in consequence, once an amount of capital has been

brought into existence the necessity of reproducing

it presents no economic problem. According to

Professor Knight "all capital is normally

conceptually, perpetual," [4] "its replacement has to

be taken for granted as a technological detail," [5]

and in consequence "there is no production process

of determinate length, other than zero or 'all

history,'" [6] but "in the only sense of timing in

terms of which economic analysis is possible,

production and consumption are simultaneous." [7]

Into the reasons why the capital maintains itself thus automatically we are

not to inquire, because under the stationary or progressive conditions, which

alone are considered, this is "axiomatic." [8] On the other hand it is asserted

that "making an item of wealth more durable" or "using a longer period of

construction," [9] i.e. lengthening the time dimension of investment in either

of the two possible ways, is only one among an "accurately speaking, infinite

number" of possible ways of investing more capital, which are later even

described as "really an infinite number of infinities." [10] According to

Professor Knight, "what the Bhm-Bawerk school's position amounts to is

simply selecting these two details which are of the same significance as any

of an infinity of other details" [11] while in fact "additional capital is involved

in very different ways for lengthening the cycle and for increasing production

without this lengthening." [12] "Time is one factor or dimension among a

practically infinite number, and quantity of capital may and does vary quite

independently of either of these time intervals." [13]

"I have full

sympathy with

those who see in

the concept of a

single or average

period of

production a

meaningless

abstraction which

has little if any

relationship to

anything in the

real world."

Against this I do indeed hold that, firstly, all the problems which are

commonly discussed under the general heading of "capital" do arise out of

the fact that part of the productive equipment is non-permanent and has to

be deliberately replaced on economic grounds, and that there is no meaning

in speaking of capital as something permanent which exists apart from the

essentially impermanent capital goods of which it consists. Secondly, that an

increase of capital will always mean an extension of the time dimension of

investment, that capital will be required to bring about an increase of output

only in so far as the time dimension of investment is increased. This is

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relevant, not only for the understanding of the transition to more capitalistic

methods, but equally if one wants to understand how the limitation of the

supply of capital limits the possibilities of increasing output under stationary

conditions.

This is not a dispute about words. I shall endeavor to show that, on the one

hand, Professor Knight's approach prevents him from seeing at all how the

choice of particular methods of production is dependent on the supply of

capital, and from explaining the process by which capital is being maintained

or transformed, and that, on the other hand, it leads him to undoubtedly

wrong conclusions. Nor does this discussion seem necessary solely because

of the objections raised by Professor Knight. In many respects his conclusions

are simply a consistent development of ideas which were inherent in much of

the traditional treatment of the subject, [14] and which lead to all kinds of

pseudo-problems and meaningless distinctions that have played a

considerable role in recent discussions on the business cycle.

II. On some current misconceptions

Before I can enter upon attempting to refute Professor Knight's assertion, it

is necessary to dispose of certain preliminary matters. There are certain

ideas which Professor Knight and others seem to associate with the view I

hold but which in fact are not relevant to it. I do not want to defend these

views but rather to make it quite clear that I regard them as erroneous.

Practically all the points to which I now call attention were either implicitly or

explicitly contained in that article of mine which Professor Knight

attacks. [15] As he has chosen to disregard them, it is necessary to set them

out in order.

(1) It should be quite clear that the technical changes involved, when

changes in the time structure of production are contemplated, are not

changes due to changes in technical knowledge. The concept of increasing

productivity due to increasing roundaboutness arises only when we have to

deal with increases of output which are dependent on a sufficient amount of

capital being available, and which were impossible before only because of the

insufficient supply of capital. This assumes in particular that the increase of

output is not due to changes of technical knowledge. It excludes any changes

in the technique of production which are made possible by new inventions.

(2) It is not true that the periods which it is contended are necessarily

lengthened when investment is increased are periods involved in the

production of a particular type of product. They are rather periods for which

particular factors are invested, and it would be better for this reason if the

term "period of production" had never been invented and if only the term

"period of investment" were used. To give here only one example: it is not

only conceivable, but it is probably a very frequent occurrence that an

increase in the supply of capital may lead not to a change in the technique of

production in any particular line of industry, but merely to a transfer of

factors from industries where they have been invested for shorter periods to

industries where they are invested for longer periods. In this case the periods

for which one has to wait for any particular type of product have all remained

unaltered, but the periods of investment of the factors that have been

transferred from one industry to another have been lengthened. [16]

(3) It is not proposed, and is in fact inadmissible, to

reduce the description of the range of periods for

which the different factors are invested to an

expression of the type of a single time dimension

such as the average period of production. Professor

Knight seems to hold that to expose the ambiguities

and inconsistencies involved in the notion of an

average investment period serves to expel the idea

of time from capital theory altogether. But it is not

so. In general it is sufficient to say that the

"This basic

mistake Ï if the

substitution of a

meaningless

statement for the

solution of a

problem can be

called a mistake

Ï is the idea of

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investment period of some factors has been

lengthened, while those of all others have remained

unchanged; or that the investment periods of a

greater quantity of factors have been lengthened

than the quantity of factors whose investment

periods have been shortened by an equal amount;

or that the investment period of a given quantity of

factors has been lengthened by more than the investment period of another

equal amount has been shortened. It is true that in some cases (e.g. when

the investment period of one factor is shortened, and at the same time the

period for which a greater quantity of another factor is invested is lengthened

by a smaller interval) the determination of the net effect of the changes of

the investment periods of different factors in different directions raises

problems which cannot be so easily answered. But the concept of the

average period, which was introduced mainly to solve this difficulty, does not

really provide a solution. The obstacle here is that the reinvestment of

accrued interest has to be counted equally as the investment of an amount of

factors of corresponding value for the same period. In consequence the only

way in which an aggregate of waiting can be described, and the amount of

waiting involved in different investment structures can be compared, is by

means of a process of summation, in the form of a double integral over the

function describing the rates, at which the factors that contribute to the

product of any moment are applied, and at which interest accrues.

capital as a fund

which maintains

itself

automatically."

It should, however, be especially noted that the assertion that it is

conceptually possible to conceive of the aggregate capital of a society in

terms of possible waiting periods does not mean that the total period of

production (or the aggregate of all periods of production) of an economic

system is necessarily a phenomenon capable of measurement. Whether this

is the case (and in my opinion it is very unlikely) is altogether irrelevant for

the problem at issue. What is essential is solely that whenever a change

occurs in any part of the economic system which involves that more (or less)

capital is used in the industry or industries concerned, this always means

that some of the factors used there will now bring a return only after a longer

(or shorter) time interval than was the case in their former use. As Professor

Knight himself rightly says, "the rate of interest which determines the value

of all existing capital goods is determined exclusively at the margin of

growth, where men are comparing large, short segments of income flow with

thinner streams reaching out to the indefinite future." [17] It is at this

margin of growth (of every individual firm and industry) where the

extensions of investment occur and where the decisive question arises

whether the productivity of investment is a function of time and whether the

limitation of investment is a limitation of the time we are willing or able to

wait for a return. [18]

(4) It is quite erroneous to regard propositions concerning the greater

productivity of roundabout methods as depending upon the possibility of

identifying the contribution of the "original" factors of the remote past. In

order to be able to give an intelligible description of a continuous stationary

process in which factors are invested at any one moment, some of whose

products will mature at almost any later moment, one of two methods is

possible. Either we can concentrate on all factors invested in any one

interval, and relate them to the stream of product derived from it. Or we can

concentrate on the product maturing during a short interval, and relate it to

the factors which have contributed to it. But whichever of the two methods

we select, in all cases only the future time intervals between the moments

when the factors are, or will be invested, and the moment when the product

will mature are relevant, and never the past periods which have elapsed

since the investment of some "original factors." The theory looks forward, not

back. [19]

(5) It is equally erroneous to regard the theory as depending on any

distinction between "original" or "primary" and produced means of

production. It makes no fundamental difference whether we describe the

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range of investment periods for all factors existing at the beginning of the

period, [20] or whether we just describe the range of periods for which those

services of the permanent factors are invested that only become available for

investment at successive moments as they accrue. I think it is more

convenient to use the second method, and to describe the investment

structure by what I have called the investment function of the services of

these permanent factors. But whether this distinctionÏwhich is based on the

fact that some of the productive resources have to be deliberately replaced,

while others are regarded as not requiring replacement on economic

groundsÏis accepted or not, in no case is a distinction between "primary" or

"original" and "produced" means of production necessary in order to give the

concept of the investment function a definite sense.

(6) Last and closely connected with the preceding point, it is not necessarily

the case that all "intermediate products" or "produced means of production"

are highly specific, and that in consequence any change in the investment

structure can only be brought about by investing the "original" factors for

longer or shorter periods. This seems frequently to be implied in analysis

which follows Bhm-Bawerkian lines. But of course there is no reason why it

should be true. The periods for which non-permanent resources are being

invested are as likely to be changed as the periods of investment of the

services of the permanent resources. [21]

III. Professor Knight's criticism based on a misunderstanding

Most of the critical comments in Professor Knight's articles are due to

misunderstandings of one or more of these fundamental points. But while

each of them seems to be the source of some confusion, probably none was

in this respect quite as fertile as number two. The idea that lengthening the

process of production must always have the result that a particular kind of

product will now be the result of a longer process, or that a person who

invests more capital in his enterprise must therefore necessarily lengthen the

period of production in this business, seems to be at the root of his assertion

that capital can be used otherwise than to lengthen the time dimension of

investment, as well as of his statement that I have practically admitted this.

As a proof of the former contention Professor Knight cites a single concrete

example, taken from agriculture. "Taking population as given," he

writes, [22] "raising more plants of the same growth period will also require

more 'stock,' but will not affect the length of the cycle, while the addition to

total production of varieties of shorter growth, say yielding two harvests per

year instead of one, will involve an increase of capital while shortening the

average cycle." Unfortunately Professor Knight only adds that "additional

capital is involved in very different ways for lengthening the cycle and for

increasing production without this lengthening," but does not tell us how

exactly the additional capital is used for increasing production otherwise than

by lengthening the period for which some resources are invested. If he had

stopped to inquire he would soon have found that even in the cases where

his quite irrelevant "cycle" of the particular process remains constant, or is

actually shortened, additional capital will be used in order to invest some

resources for longer periods than before, and will only be needed if this is the

case.

As Professor Knight has not stated why, in his example, either of the two new

methods of cultivation will only be possible if new capital becomes available,

it will be necessary to review the different possibilities which exist in this

respect. Changes in technical knowledge must clearly be excluded and

apparently Professor Knight also wants to exclude changes in the amount of

labor used, although it is not quite clear what the assumption "taking

population as given" exactly means. If it is to mean that the quantity of all

labor which contributes in any way to the product is assumed to be constant,

and to be invested for a constant period, it is difficult to see how, with

unchanged technical knowledge, they should suddenly be able to raise more

plants and to use more capital. There seem to be only three possibilities, and

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